All Change? Grounds for optimism?

What will the Labour Government do about ground rents?

Within their manifesto, Labour committed to “tackle unregulated and unaffordable ground rent charges”. As with many of their manifesto commitments, it’s short on detail. But, the fact that that commitment made its way into the famously ‘commitment light’ document, suggests it is a priority they’ll want to deliver on pretty rapidly now they’re in Government. And, from the party’s previous policy promises, coupled with what key party players said in the last Parliament, we can make a fair guess as to what is likely on the horizon.

In the beginning

Ground rents are nothing new. They’ve existed in long leases granted in England for hundreds of years and, until recently, almost no one was much bothered by them. They’re an annual payment from tenant to landlord and are part of the ‘deal’ struck between the original landlord and original tenant at the outset of the lease. They’re not paid in return for any service provided by the landlord so, in that respect, they’re very different from service charges (sums paid to cover, say, the costs of the landlord maintaining the building) or insurance rent (sums paid to cover the cost of the landlord insuring the building).

For centuries, most ground rents have been set at pretty low figures - rarely much above £200 in today’s money. And often less than that. Not hugely difficult for individual tenants to pay in the course of the year. But, for landlords owning a portfolio of properties let on long leases, they mounted up to a nice steady income. And, because of the landlord’s ability to forfeit the lease (i.e. bring it to an end without compensation) if the tenant defaulted, tenants have very rarely defaulted.

Downhill

As with many things in the world, it all began to go downhill about 30 or so years ago.

A number of residential developers realised that ground rents could be an extra source of income. If they reserved a sufficient ground rent on each sale then, once they’d sold all the homes on a development, they could make a final sale of the underlying freehold. Since that underlying freehold had the benefit of the ground rents coming in every year, it realised a hefty additional sale price. Even that wasn’t a problem, as long as individual rents continued to be set at pretty low rates.

Developers and their solicitors then began to include new drafting to ensure that, over the course of the years, the rent went up. And even that wasn’t a problem, as long as the increases were modest and just reflected the fact that £200 will buy you more today than it will in 100 years’ time.

The problem came when developers and their solicitors, either by design or because they didn’t think through to the logical conclusion of their drafting, included provisions such that the ground rent doubled at regular intervals - every 5 or 10 years was common. That meant that, what began as a modest rent at the start of the lease, became eye wateringly extortionate later down the line. And that is the problem. Tenants were being required to stump up thousands each year for homes that, as far as they were concerned, they’d already bought. Some couldn’t pay and lost their home. Lots of others couldn’t sell, since no one who spotted the problem in advance was going to walk into it. Mortgagees wouldn’t lend. The Competition and Markets Authority got involved and there was a general perception that homes had been missold, with little or no explanation being given to new leaseholders as to what they were getting themselves into. Ground rents became a much-publicised scandal.

The story so far

To give them their due, the last Government did begin to address the issue. The Leasehold Reform (Ground Rent) Act 2022 now prohibits ground rents above a peppercorn in almost all new long residential leases. A peppercorn is a fancy legal way of saying zero.

There are only a few exceptions such as some business leases, leases granted by community land trusts or certain co-ops and leases used in Sharia-compliant mortgage structures.

So, going forward, very few new residential leases will be granted with meaningful ground rents and, for those few that are still allowed to have them, there are logical reasons for that.

Problem solved?

Well, unfortunately not. That still leaves almost 5 million long leases, most of which will include ground rents and some of which will contain the sort of ground rents which are problematic. Hence Labour’s commitment to do something. But what?

Abolition?

One option would be to enact legislation to retrospectively set all ground rents to a peppercorn. That would be relatively easy in legislative drafting terms but, if Labour were going to do that, they would likely have said so in their manifesto. And they didn’t. They committed to ‘tackle unregulated and unaffordable ground rent charges’ not to abolish them. And there is good reason for that.

Whilst great for leaseholders, outright abolition could create real economic and legal problems.

Ground rent income streams have, over the last few decades, become a significant asset class in their own right. As referred to above, for a landlord owning a large portfolio, they provide an incredibly safe and predictable income. So, particularly after the 2007/8 financial crisis, many pension funds and life assurance companies invested heavily in the class. Making that asset class valueless overnight, with the stroke of a legislative pen, would have a massive economic impact, at a time when Labour, to support their number one agenda item (growth), wants to present us as a safe and stable nation to invest in.

Even if Labour were willing to take a view that that hit were something they could live with, it’s unlikely that the funds and investors would take it lying down. They’d likely take the Government to Court alleging a breach of Article 1 of the First Protocol of the European Convention on Human Rights (as applied in the UK via the Human Rights Act 1998).

A1P1, as it is known, states that “Every natural or legal person is entitled to the peaceful enjoyment of his possessions. No one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law and by the general principles of international law.”

Whole books have been written on A1P1, and a full analysis of it is beyond the scope of this article. But, in brief…

1. Generally speaking, even a Government can’t just take away someone’s property, or control the way they use it, without good reason.
2. When we say ‘someone’, companies are someones too.
3. This isn’t an absolute ban. But if a Government is taking away someone’s property (or controlling the way they use it) they must act fairly and they must be doing so for a good reason (i.e. for the good of wider society).
4. It will be easier for a Government to show they’ve acted fairly if they’ve compensated the someone.
5. That compensation doesn’t necessarily have to be the full market value of what the someone has lost, as long as it is fair in the circumstance and fair given the benefit secured for wider society.

If the Government went for total abolition without compensation, then they might be on shaky ground. When anyone thinks about ground rents, they think of the horror stories. But the horror stories are, whilst hugely painful for those affected, few and far between. There are millions of ground rents set at below £200 per year and, frankly, they aren’t causing much of a problem. So, whilst it would be easy to show the societal benefit of getting rid of the problem ground rents, getting rid of all of them is a more difficult sell without compensating the landlords who are losing out.

And compensation is, realistically, out of the question. The capital value hit which landlords would suffer on complete abolition is estimated at £27.3bn. The Government is not going to find that sort of money down the back of the sofa at No. 10.

Options

Alternative options have been discussed. Most notably the previous Government launched a consultation around Christmas 2023 on 4 options (in addition to abolition). These were:

• Capping ground rent at an absolute maximum (say £250)
• Capping ground rents at a percentage of the property value (say 0.1%)
• Capping ground rent at the original amount it was when the lease was granted.
• Freezing ground rent at current levels

The Labour Government has inherited the results of that consultation. And, in theory at least, the policy objectives of the last Tory Government and this new Labour Government are pretty much aligned in this area. So, it seems unlikely the Government will feel the need to re-consult.

And Labour’s New Deal for Leaseholders (admittedly pre-Starmer policy) committed to cap ground rents for existing leaseholders at 0.1% of the property value, up to a maximum of £250 a year.

Our fair guess as to what Labour will now do…

So, if were betting people (which we absolutely are not) we’d bet on there being a quick review of the consultation responses followed by legislation to cap ground rents for existing leaseholders at 0.1% of the property value, up to a maximum of £250 a year. That way Labour can tick off a manifesto commitment and avoid having to compensate landlords whilst delivering a policy objective that all wings of the party would be proud to put their names to.
This article, written by Neil Toner, is one of our ‘All Change’ series analysing the likely impact of Labour’s manifesto commitments, now they’re in power. Visit our All Change article hub to read all available articles.